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Some of the key developments that are currently reshaping the derivatives market are: (i) the use of smart contracts; and (ii) the implementation of digital asset referencing derivatives.
In this chapter, we cover the potential benefits that these technologies bring, some of the challenges that remain as obstacles to their widespread use, and the work that industry bodies are doing to facilitate their adoption in the market. We also briefly discuss some of the legal uncertainties and potential litigation risks arising from these developments.
Use of smart contracts
As the market continues to develop, market participants are showing ever-increasing interest in smart contracts. This interest stems from a growing body of evidence that, as detailed further below, their use in appropriate circumstances can bring with it significant efficiencies and benefits.
In response to this enthusiasm, industry bodies such as the International Swaps and Derivatives Association (ISDA) have been working with its market participants on the development of technologyenabled solutions (including the use of smart contracts), which will allow a fundamental reshaping of the derivatives infrastructure. ISDA's view is that these solutions should improve operating efficiency, reduce operating costs and risk, and increase both quality and transparency of data.
What is a "smart contract"?
There is no universally accepted definition for "smart contract", but this term is commonly used to refer to legal contracts (or elements of legal contracts) being represented and/or executed by software. The term "smart" refers to the fact that some elements of a smart contract are automatic and self-executing pursuant to pre-defined conditions.
The market is evolving to differentiate a "smart legal contract" from a smart contract code. A smart legal contract is a legally enforceable contract in which some or all of the contractual obligations are performed automatically by a computer program. A smart contract code, on the other hand, would not necessarily form part of a smart legal contract, but would constitute a piece of code (or programming language) designed to provide for the execution of certain tasks by a machine. The latter could indeed simply automate the performance of a natural language contract.
The nature of smart legal contracts is such that determining jurisdiction may be a challenge. The determination is potentially important though, as different jurisdictions will take different approaches to them. In the UK, for example, the UK Law Commission published advice that "the current legal framework in England and Wales is clearly able to facilitate and support the use of smart legal contracts, without the need for statutory reform". The advice states that a smart legal contract will be held to the same standard as a traditional legal contract, but this approach is not likely to be replicated universally.
Potential advantages of smart contracts
- Increased operational efficiencies – with contracts capable of being executed immediately following the completion of a condition, delays and errors associated with the human processing of contracts and information can be avoided. Furthermore, the terms of the contract can also be automatically adjusted and updated if necessary, reducing the possibility of delay and error that would be present in a manual process.
- Reduction in performance risk – in a traditional contract, there is a promise to be fulfilled in the future and the risk that it may not take place. The use of automated code in a smart contract can, assuming that the code is accurate and produces its desired effect, reduce the risk of non-performance by a counterparty.
- Reduced costs – the elimination of intermediaries can also cut the costs they introduce into the process of actioning a contract.
- Transparency – if the smart contract utilises blockchain technology, the parties to a smart contract will have access to the same single source of information simultaneously, removing the possibility of deliberate or accidental manipulation of terms and discrepancies.
- Security – smart contracts are most often encrypted and, as above, when the smart contract is based on blockchain technology, the data becomes immutable, with anyone seeking to make changes needing to alter the entire chain to change a single record.
- Decentralised finance (DeFi) – as further detailed below, smart contracts are being tested for use in issuing, servicing, trading and settling of various digital asset-based derivatives, opening up new opportunities and innovative products in the digital asset derivatives space.
Latest developments in the derivatives market
ISDA has undertaken a significant amount of work in recent years to facilitate the use of smart contracts across the derivatives industry. This includes:
- The issuance of the Common Domain Model (the
CDM), the latest version of which (ISDA CDM 6.0)
was published in 2025. The CDM is a standardised solution aimed at
providing market participants with a common digital representation
throughout the lifecycle of a derivatives transaction. In 2021,
ISDA, the International Securities Lending Association
(ISLA) and the International Capital Markets
Association (ICMA) entered a memorandum of
understanding to work together on the development of the CDM, and
in 2022 they appointed the Fintech Open Source Foundation
(FINOS) to provide a repository to facilitate
open-source distribution. In June 2024, ISDA announced that the CDM
will be the vehicle for achieving standardised and automated
collateral management processes. VERMEG was the first to integrate
the CDM into its collateral management systems and did so in June
2024.
To aid the use of the CDM, ISDA published its 2021 ISDA Interest Rate Derivatives Definitions (the first to be published in a natively digital format). They were specifically drafted so that the definitions use formulae instead of legal narrative to describe concepts such as day-count fractions and interpolation so as to allow them to be more easily machine readable. The intention is also that, in time, the mechanics of the definitions will also be available via open-source code and aligned with the CDM in order to allow them to be consistently interpreted by automated systems. - ISDA previously published a series of papers focused on providing Legal Guidelines for Smart Derivatives Contracts. These papers set out ways in which derivatives contracts may be modernised and automated through the use of blockchain technology and other fintech developments, beginning with an Introduction to the subject in January 2019.
- On 23 June 2020, ISDA launched the ISDA Clause Library, which sets out standardised drafting options for frequently negotiated provisions within the ISDA Master Agreement. The database has improved the efficiency of contract negotiation and facilitated the digitisation of legal documentation. The ISDA Clause Library has since been expanded to include ISDA's collateral documentation and part of it was later made available digitally for the first time via ISDA Create, allowing users to produce and agree documentation online, as well as store legal data from these documents.
- On 22 November 2022, ISDA launched Digital Regulatory Reporting (DDR) 1.0. As of May 2025, DDR now supports compliance with 11 core regulatory reporting regimes, including the US, Japan, the EU, the UK, Australia, Singapore and Canada. Using the CDM, DDR transforms interpretations of regulatory amendments into code and allows market participants to view industry interpretations of regulation.
- On 26 January 2023, ISDA published new standard documentation for the trading of digital asset derivatives along with an accompanying white paper, the ISDA Digital Asset Derivatives Definitions. This has created a standard contractual framework around the ISDA Master Agreement in the hope that setting out standard provisions will aid the assessment of market risk and the contractual obligations involved, creating greater certainty for market participants.
- In December 2023, ISDA published "Tokenized collateral model provisions in ISDA 2016 Credit Support Annexes for Variation Margin (VM)" (the Model Provisions) followed by a guidance note on tokenised collateral on 21 May 2024. Both the Model Provisions and the guidance note aim to facilitate the use and enforceability of security and collateral arrangements that utilise distributed ledger technology (DLT).
ISDA has acknowledged the challenges in implementing the use of smart contracts (and other technologyenabled solutions) in the derivatives space and has established a number of internal committees and industry-wide working groups to focus on technology-related topics. These include the ISDA Legal Technology Working Group, the ISDA Smart Contracts/DLT Legal Working Group, the ISDA CDM Design Working Group and the ISDA Clause Library Project.
Issues and challenges to be considered from a buy-side perspective
It is promising that a number of jurisdictions have turned their attention to the interaction of smart contracts with the existing legal system. To take England and Wales as an example, the UK Law Commission has recently expressed its view that English law is able to facilitate and support the use of smart legal contracts without the need for any statutory reform. However, there are a number of issues and challenges that will need to be considered by ISDA in its discussions with market participants to facilitate the transition of the derivatives market towards the use of smart contract code and smart legal contracts.
Scope of automation: operational and non-operational clauses
The main payment and delivery obligations in respect of a derivatives transaction are dependent on conditional logic, so these would be well placed for being represented into a smart legal contract. However, not all clauses are susceptible to being automated and self-executed. Certain legal terms are subjective in nature and would produce ambiguity if represented in smart contract code.
The materials produced by ISDA relating to the use of smart contracts in the derivatives space suggest that when determining which parts of a derivatives contract are susceptible to automation, it is helpful to distinguish between operational and non-operational clauses. Operational clauses would generally The materials produced by ISDA relating to the use of smart contracts in the derivatives space suggest that when determining which parts of a derivatives contract are susceptible to automation, it is helpful to distinguish between operational and non-operational clauses. Operational clauses would generally
Issues with legal validation
In order to ensure that a smart legal contract produces its intended legal effect, it may be prudent for parties to obtain "legal validation" of its automated provisions (or smart contract codes) by a lawyer. However, this presents its own challenge and would require the lawyer in question to understand the programming language. It follows that there is the need for programmers to work in collaboration with lawyers to leverage their legal insight into which parts of the ISDA documentation framework would be legally effective if converted into an automatable form. ISDA is expected to play an important role in facilitating this work.
It will be challenging for non-operational clauses that include some degree of subjective interpretation (e.g. where a party is required to act in good faith or in a commercially reasonable manner) or those that are more complex in nature (e.g. when an event of default is linked to the occurrence of a specific event outside the contractual relationship and that is not easily asserted) to be legally validated. In addition, even if legally validated, there is a risk that the smart contract code will produce terms at the transaction confirmation level that are inconsistent with terms in the ISDA Master Agreement (or schedule). Appropriate mechanisms for resolving any consequent conflicts will need to be considered.
Issues with automation
Not all provisions, when automated, would produce the same effect as if complied with in their original form (i.e. in natural language) without automation.
By way of example, upon the occurrence of an event of default under a derivatives contract, the non-defaulting party would have the right to terminate the outstanding transactions. Under normal circumstances, under a non-automated contract, there are a range of factors that the non-defaulting party would take into account before pulling the trigger – these tend to be subjective and include commercial considerations, the relationship context at the time of the event, and the nature of the default. It would be difficult to cater for these factors when translating event of default provisions into programming language. In practice, the occurrence of an event of default under a smart legal contract would usually be self-automated, so it would automatically trigger the termination of any outstanding transactions.
ISDA has proposed to work with its members to select provisions within the ISDA documentation framework that are best suited for automation – their goal is to select provisions that can be automated without changing their legal effect.
Interaction with third-party data and platform providers
Where a smart derivatives contract involves the use of external, third-party data sources (sometimes referred to as "oracles"), there may be risks posed by data inaccuracies, whether caused by error or deliberate manipulation – particularly if hacking is involved.
For instance, smart derivatives contracts for foreign exchange (FX) derivatives will use an external data source to determine FX rates. In a situation where payment or delivery is automatically triggered by data from an external source (e.g. if automation involves any straight-through processing), the prospective apportionment of liability in the event of a third-party data failure should be considered.
In addition, consideration should be given to what alternate mechanism should be used where there is a breakdown in communication between the third party and the smart contract, due to, for example, a software programming bug or a coding error on the part of the third party. This could be with recourse to manual input.
ISDA has also identified cryptocurrency as an area of concern when considering interaction with thirdparty platforms. On 26 January 2023, ISDA published a white paper specifically looking at the legal risk questions that come with holding cryptocurrency in exchanges or intermediaries and, specifically, the possible issues that may cause for netting and collateral enforceability. These considerations were built upon in a further white paper published by ISDA on 3 May 2023. This white paper focuses on how digital assets held through intermediaries will be affected by the insolvency of the intermediary. ISDA identified that, from a US and English law perspective, private legal concepts such as trusts, existing insolvency regimes and rules requiring segregation of assets all act as protections for digital assets held with intermediaries. However, the white paper also highlights that issues surrounding which governing law applies and which courts have jurisdiction to enforce claims still require significant consideration. As cryptocurrency is an area that still lacks significant regulation, these ISDA white papers offer insights to market participants to ensure that they are aware of different market risks. In this paper, ISDA suggests that development of contractual standards will be crucial in providing clarity in this area.
Complex and bespoke derivatives contracts
Certain derivatives contracts can be heavily negotiated and customised to apply to bespoke arrangements made between the parties. The level of customisation might vary depending on counterparty type and product complexity. Examples of highly customised arrangements include total return swaps, longevity swaps and other structured finance products that will likely be made under a wide set of documents forming the overall derivatives architecture where various levels of obligations apply across different parts of the documentation. It would be challenging to translate these interlinking obligations into programming language in a straightforward manner.
The recent regulatory developments in the derivatives space (which follow a global trend since the global financial crisis) have also contributed to the complexity of certain derivatives contracts; e.g. there is an increase in the use of third-party custodians when implementing collateral arrangements to deal with certain margin requirements, and there are additional layers of complexity arising from the need for certain over-the-counter derivatives transactions to be centrally cleared. Technology can provide greater clarity for these regulatory complexities and DDR is an example of this. By using code to set up a framework that makes industry interpretation of Commodity Futures Trading Commission (CFTC) rules widely available, DDR promotes consistency as market participants are always able to refer to the same industry standard.
Laws affecting contractual performance
Certain laws might have the effect of interrupting the performance of contracts – e.g. where a provision under a specific contract is rendered void, or where a contractual stay is applied to a party in financial distress under the applicable regulatory regime. How would smart legal contracts interact with these laws? This is another issue to be considered by ISDA in its discussions with market participants.
Liquidity concerns
Once the market has moved to address most of the key concerns that are set out in this chapter, it is likely that only the largest and most sophisticated market participants will be able to start using smart legal contracts. The smaller or less sophisticated players, including many buy-side entities, might find it more challenging and costly to adapt their processes to the new "reshaped" derivatives market.
It is clear, therefore, that a number of challenges remain to be addressed before widespread use of smart contracts in the derivatives space can take hold. However, steps towards adoption are being taken. For example, in May 2025, DZ Bank completed a third pilot transaction using a smart derivatives contract with Union Investment in order to hedge interest rate risk. Vanguard has also partnered with State Street and Symbiont to utilise DLT to enable the underlying FX forward contracts across its funds to be digitised and automated into a smart contract. The expectation is that the use of smart contracts and blockchain technology could minimise counterparty risk in the FX forward currency market by around 80% compared to the existing standard.
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Originally published by Global Legal Insights
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